The Risk/Return Trade-Off
Your financial goals will help determine the right level of risk in your portfolio.
Over the long term, higher-risk investments, such as equities, have historically tended to outperform lower-risk investments, such as bonds and money market instruments. But with higher-risk investments, you also have a greater chance of negative returns from time to time. Whether or not this trade-off is worth it will depend on your financial goals and overall risk tolerance, and perhaps more importantly, on how long you have to achieve those goals.
Is time on your side?
For short-term goals, such as a well-deserved trip abroad, taking on more risk for the potential of a higher return doesn’t make sense. When you need to cash out your investment relatively soon, choose a liquid investment that you can access quickly and that has very little risk of negative returns.
For longer-term goals like retirement, you should give the risk-reward trade-off some serious consideration.
When you started saving for retirement, you were likely in your early thirties, or maybe even your twenties. At that age, you should be looking at higher-risk investments like equities and equities-based mutual funds. These investments can sometimes lose value, but when retirement is more than 30 years away, you have time to recover your losses. And the higher return potential of these investments means you might reach your retirement goals sooner.
In your forties and early fifties – depending on when you plan to retire -- a reasonable amount of risk is still (generally) acceptable. At this age, you’re still focused on maximizing your returns to keep your retirement goals on track, and you still have time to recoup moderate losses. That said, this is a good time to re-evaluate your portfolio’s risk level and consider including lower-risk investments like government bonds and money market securities. You won’t earn much interest on these lower-risk investments, especially in today’s environment, but they’ll help you preserve some of your capital.
The closer you get to retirement, the more you’ll want to focus on capital preservation over potential returns. By the time you’re in your mid-to-late fifties, you may want to consider looking at lower-risk options. After decades of striving to maximize your portfolio’s return potential, this can be a tough transition for some investors. But making up for severe losses at this point could take more time than you have left to invest, which could put your retirement goals and dreams at risk. Just remember that people are living longer than ever, so you still need some growth in your portfolio to ensure you have the money you need throughout retirement.
If you think it’s time to make some changes, I can help you review the level of risk in your portfolio and whether it makes sense for your stage in life. I can also help you transition to a more cautious investment approach when the time comes.
To learn more about getting the right risk-return balance in your portfolio, call our office today.